Uncertainty takes hold

Market analysis
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4/21/2017

The most professional polls on the French presidential election outcome are suggesting a number of possible combinations for the second round play-off. And naturally, volatility has resurfaced on markets.

For many weeks, financial assets traded in particularly narrow spreads as long as markets managed to shrug off mounting political and geopolitical uncertainty.

But it is clear that volatility has risen in recent days across Europe’s leading equity indices. With politics finally upstaging the global economic picture, gold and the Japanese yen have continued to advance while yields on US and German government debt have eased. But if investors’ risk appetite has waned, we see no blanket retreat in risk assets: international equities and credit markets, for example, have been particularly resilient.

Looking forward a few months and assuming that the media fuss will die down a little after the first round, we believe flows into European equities could resume. After all, Europe has been shunned for more than a year and the zone’s equity markets are more attractive in relative value terms than the US. We also think that Japan could emerge from several difficult months and once again benefit from its exposure to the ongoing global recovery.

European equities

Markets seemed almost relieved the week was ending after a long period dominated by opinion polls on the French presidential elections. The focus was instead on relatively upbeat first quarter results. L’Oréal saw luxury product sales increase by 12.2% or double the +6% pencilled in by analysts but its mass market sales slowed sharply. Asia rose 7%, offsetting mediocre performance in Europe and North America. Edenred enjoyed a big rise on markets after sweeping past expectations with strong 8% like-for-like growth that was also helped by recent acquisitions. Nestlé’s results were slightly better than expected and the group reiterated its annual objectives.

Publicis, unsurprisingly, remained strong in Europe and weak in the US. Schneider’s like-for-like sales (+3.1%) easily beat expectations of a 0.4% increase. Accor reported 7.4% in like-for- like growth, a pleasant surprise and another sign of higher RevPar over the quarter. Trends in Europe and Asia look promising.

However, Burberry's disappointing results contrasted with previous reports from other luxury sector players. Like-for-like figures at Rémy Cointreau were also slightly disappointing but Pernod Ricard’s sales rose 3%, or more than expected, due to excellent contributions from Europe and the Americas. Michelin’s robust sales offset lower prices over the first quarter. Danone’s figures were in line, proof that the group was confronting the same difficult trends in Europe and the US as other major consumer staples players.

Elsewhere, Vivendi could be forced to divest some assets so as to comply with Italy’s anti-concentration rules in the telecoms/media sector. The news revived interest in Mediaset. As part of Akzo Nobel’s poison pill strategy, the chemicals division will be spun off either through a simple trade sale or a market listing.

US equities

US equity markets edged higher in a week with few major economic indicators or political events. In the ongoing earnings season, Verizon’s results reflected mounting competition with an increasing number of unlimited phone offers. But Kinder Morgan (infrastructure) and CSX (freight and logistics) posted robust results. Construction company DR Horton reported strong profits and revised up its sales guidance for this year. In technology, IBM’s results were mixed; the group’s transformation is clearly going to be a long haul. In banks, there were no big surprises from Bank of America and Goldman Sachs. Bank of America unveiled an improvement in investment banking.

Over the last 5 days, consumer discretionary, tech and industrials led advances. Energy plunged more than 3%, followed by utilities and telecoms which both lost less than 1%.

Japanese equities

The TOPIX ended the period 0.8% higher. Japanese equities rebounded on Monday with investors buying on the previous week’s dips. But the upward trend was capped amid a wait-and-see mood prior to the French Presidential elections. Investors were also sensitive to escalating geopolitical tensions over North Korea and exchange rate movements prior to the release of earnings reports from leading companies. Investors preferred domestic related stocks that have greater immunity to any overseas developments and exchange rate fluctuations.

Banks (+2.2%) and Other Financing Business (+2.6%) advanced from the previous week. Electronic makers Toshiba Corporation (10.7%), Fujitsu (5.3%) and Sony Corporation (4.4%) were buoyant during the period. Toshiba Corporation soared on news it was looking to lay off a thousand employees.

Japan Post Holdings plunged following a news report that the company would suffer from an impairment loss over its 2015 acquisition of Toll Holdings, an Australian logistics firm.

Emerging markets

Emerging markets were stable this week. Lower oil prices and higher volatility in domestic Chinese markets weighed on performance but US dollar weakness and the surprisingly strong 6.7% rise in China’s first quarter GDP made a positive contribution.

Any weakness on Chinese markets was prompted by measures from financial regulators, the CSRC and the CSDCC in particular, aiming to improve market transparency and reduce bad financial products. There was a strong focus on the famous high-yield wealth management products which are backed by often dubious underlyings. Amid these ongoing positive reforms, the central bank carried on with efforts to stabilise liquidity, so far successfully. The fear of a replay of summer 2015 is much less plausible this time.

In India, the IT sector reported unexciting fiscal fourth quarter results. YoY EPS at TCS and Infosys rose by 4.2% and 2.1%. Both companies reported lower margins, partially due to the strong rupee. Infosys lowered its revenue guidance for the next 12 months from +6.5/8.5% to +6.1/8.1%. In the banking sector, results at IndusInd Bank and Yes Bank rose 21% and 30% YoY despite rising NPLs due to downgrades in the cement sector. However, this is not really a concern as the sector continued to consolidate and restructure. Jaiprakash sold some of its cement assets to Ultratech so creditor banks will recover a significant part of these NPLs which, in absolute terms, remain low, around 1% of total loans.

In Brazil, the main highlight was the Lower House commission negotiating with the government on pension reform. The minimum retirement age for men was kept at 65 and reduced to 62 from 65 for women. There were some changes on the transition rule too. All in all, the changes represent a 30% dilution of the original proposal (the market was expecting 50% dilution). The final vote in the committee is scheduled for May 2. The government also submitted its labour reform plan for urgent approval. The minutes from the Bank of Brazil’s Copom indicated that the size of interest rate cuts might increase (the last cut was by 100bp to 11.25%). We expect first quarter results from Brazilian companies to benefit from lower costs and financial expenses and post 15% in EPS growth.

In Argentina, the central bank said it planned to increase FX reserves gradually from 10% to 15% of GDP. The measure could weigh on the Argentine peso but we expect strong US dollar inflows this year so we believe this will be positive in the long run.

Commodities

Tensions over North Korea and France’s elections had fuelled market trends in recent weeks and affected oil and gold markets but this week concerns abated somewhat and the risk premium fell. The gold ounce is around USD 1,280, after hitting a high of USD 1,295, a level which had not been seen since the beginning of November 2016 just ahead of the US Presidential Elections. We expect it to stick around these levels until the second round of France’s elections. Oil price volatility was well and truly back even if Brent crude has traded between USD 50 and 57 since the beginning of 2017. The retreat to USD 53 was triggered by weekly statistics which showed US crude inventories falling less than expected as well as an unseasonable rise in petrol stocks.

The previous day had seen the Department of Energy’s oil production forecasts in its Drilling Productivity Report. The DOE expects output to increase by 123,000 b/d in May, a 2 year-high as far as monthly growth is concerned. Following a first monthly drop in oil inventories in February, the IEA sees them dropping more sharply in coming months but OPEC efforts may fall short of taking stocks back to their historic mean. Led by Saudi Arabia and Kuwait, OPEC countries, as well as Russia, seem to be in favour of extending the output cut agreement by a further 6 months. Comments from various oil ministers will influence markets up to the May 25 meeting.

Elsewhere, the market is worried about tighter lending conditions in China but March data on GDP, infrastructure spending, housing starts and electricity production all suggest the Chinese economy is on an uptrend.

Iron ore had traded as high as USD 95/t in mid-February, but has now hit USD 63, its lowest level since October 2016, where it seems to be stabilising.

Corporate debt

Credit

It was a relatively quiet week on high yield markets ahead of the first round of France’s presidential elections. Following on from the narrowing OAT/Bund spread, the Xover tightened to 292bp while the iTraxx Main remained somewhat stable around 75bp.

In a quiet new issues market, Nomad Foods raised EUR 500m with a senior secured 7NC3 bond and Unilabs sold EUR 250m in 8NC3 senior notes to fund its acquisition of Alpha Medical. The new entity is expected to have EUR 790m in sales and EUR 162m in adjusted EBITDA. Voyage Care raised GBP 250m to refinance existing debt. On the rumour mill, Abertis was reportedly approached by Atlantia and Europcar is said to have bid for Goldcar, a Spanish low-cost car rental company with EUR 1bn in enterprise value.

Convertibles

The convertible bond market was subdued this week as earnings blackouts and the imminent French presidential elections conspired to limit both primary and secondary activity. We expect new issues to pick up again in a couple of weeks after Q1 earnings reports have been published.

As for earnings, Sony revised its guidance for fiscal 2017 operating profit upwards largely owing to lower costs in the semiconductor segment, although the company’s sales guidance remained unchanged.

In Asia ex-Japan, ASM Pacific published impressive Q1 results - the gross margin was 3 points ahead of consensus at 39.9% and net income jumped fivefold to HK$736 million, with the stock subsequently surging as much as 8%. In Europe, Severstal revealed solid Q1 figures, with revenue up 61.1% YoY and EBITDA up 112% on favourable pricing momentum. The company also surprised positively by announcing it was paying out all of Q1 earnings as a dividend.

In the US, data protection player, Proofpoint, astounded its critics by reporting a 43% increase in Q1 revenue on persistently strong demand for cloud-based cyber security products; the stock jumped 5% in afterhours trading. On a less positive note, Electronics for Imaging fell over 12% after releasing disappointing Q1 results which included a 2% YoY decline in sales due to weakness in its core US market.

In other news, although Moody’s noted no change in rating, both credit and equity markets reacted negatively on hearing that DISH Networks had spent USD 6.2bn in the FCC’s 600MHz spectrum auction compared with expectations of 3-4bn. Meanwhile, one would-be suitor, T-Mobile, bought more than expected and another, Verizon, bought none, raising concerns that there might be diminished interest in acquiring or partnering with DISH to get access to its larger spectrum portfolio.